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In 2018, the Food Marketing Institute reported that the average price for organic produce was 54% higher than for non-organic goods. Meanwhile, traditional, non-organic forms of generating retirement income based on the capital markets are expensive. Yet their cost remains the status quo. Among advisors, 87% continue to use a withdrawal strategy according to the recently released Protected Retirement Income and Planning study conducted by Cannex and The Alliance for Lifetime Income.
From paltry dividend yields to low bond yields, to 3% or less being the new 4% “safe” withdrawal, producing income takes lots of money using traditional approaches.
For example, $50,000 hardly qualifies as high income, but one needs a high-net worth to produce that amount with traditional methods. Using AAA-rated corporate bonds yielding about 2.4%, the cost of that $50,000 income is almost $2.1 million. The dividend yield on the S&P 500 is barely 1.3%, meaning $50,000 costs almost $4 million. The alternative is higher dividends but with single-stock risks. A 4% “safe” withdrawal requires $1.25 million, and 3% (is 3% the new 4%?) almost $1.7 million.
None of those are guaranteed.
Meanwhile, a deferred annuity with a lifetime withdrawal benefit – purchased in one’s 60s – can generate that same $50,000 for much less. Some products offer an immediate cashflow around 5% of the purchase amount. And, with a deferral period, those withdrawal rates only go up, pushing the “cost” of that $50,000 income down.
For example, a fixed indexed annuity (offered by Symetra) with a guaranteed lifetime withdrawal benefit covering a single life has a guaranteed withdrawal rate of 5.25% of the purchase amount for withdrawals commencing immediately after purchase at age 60-64. (That rate climbs with five-year age brackets, and to cover two lives the withdrawal rates are reduced by 0.50%.) If the 60–64-year-old couple waits five years, their lifetime withdrawal rate grows to 6.5% of their purchase amount.
Several firms offer indexed annuities with a guaranteed lifetime withdrawal benefits in the same general ballpark. Some have put their focus into making immediate cash flows look more competitive, while others have chosen to compete on deferred outcomes.
The law of large numbers helps drive the relative cashflow bargain those annuities offer, in terms of both human mortality and behavior metrics. That human element creates an organic component to annuity pricing, which is more predictable in its patterns and outcomes. This lends annuities an advantage compared to the less predictable timing and scale of capital markets performance on which many non-annuity cash flow methods rely.
For example, human mortality is highly predictable on average. Single-premium immediate annuities (SPIAs) are priced for average mortality outcomes (with some padding for improvement), meaning everyone in that mortality pool who buys an annuity can benefit from the first check. A SPIA owner enjoys a cashflow not available to those who must make very conservative assumptions about mortality and markets to execute a non-guaranteed withdrawal rate that appears sustainable, whether linear or dynamic. Hence the term “mortality credit” is associated with SPIAs – the ability to reap financial advantage from knowledge about highly predictable mortality. While annuities are not immune to the pricing impacts of low rates, mortality credits do help. An online quote service shows the best joint-payout rate at age 60 of $5,158 for life only on a $100,000 purchase, with $4,977 female and $5,209 male.
But life-only annuities, like SPIAs, require a binary choice that can be hard to accept, since there is nothing left for heirs. Enter the deferred annuity with the lifetime withdrawal guarantee, which doesn’t have that binary feature. Add human behavior along with human mortality to the pricing mix for further cashflow lift. Insurers know that many who buy these contracts will never exercise the withdrawal feature for a variety of reasons, even if they’ve paid a fee for it. Call it a “behavioral credit’ enjoyed by owners of these annuities who use the feature, in addition to the mortality credits associated with SPIAs. Those who don’t exercise the benefits subsidize those who do. Those who die early subsidize those who live long. All who exercise the benefit to the fullest should expect their contract values to be fully consumed within 20 years or less, even though the guaranteed cashflow will continue. As such, these contracts are built to facilitate consumption (with the option to stop) and improve planning precision by reducing reliance on assumptions.
Annuities make the cost of retirement cashflow less expensive, particularly for those who plan. Using our prior indexed annuity example, producing a desired $50,000 lifetime cashflow starting at 65 covering two spouses requires a purchase amount at age 60 of $769,231. Those using the 4% withdrawal approach and looking five years ahead will need $1.25 million at that time, or $1.7 million if they think 3% is more sustainable. If they already have that money, they will need to keep all of it in very conservatively managed assets to ensure it’s there when they retire. If they don’t have that money but want that cashflow without an annuity, they’ll need to invest aggressively to get there, and fight the headwinds of expensive capital markets and potentially below average returns.
When it comes to relative bargains in retirement cashflow, go organic and consider the role annuities play in bringing capital efficiency to a retirement-income strategy.
John Rafferty has spent much of his 30-year career building annuity marketing departments at MassMutual, AIG/American General, and Symetra. He holds a B.A. in economics from Colby College and an M.A. in public policy from Trinity College, and currently operates an annuity sales and marketing consultancy, RaffertyAnnuityFraming.com.
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